Business Directories

Economic revival to drive Iraq banking sector

Dubai, July 14, 2013

The Iraqi banking sector is set for significant earnings and asset growth over the next decade driven by a strong macro environment, increasing credit penetration and the improving security situation in the country, a report said.

With the International Monetary Fund (IMF) forecasting Iraq’s GDP to grow at a rate of 9 per cent in 2013, the banking sector in particular is expected to maintain steady growth over the next few years, added the new report on Iraq’s banking sector released by Sansar Capital Management, a leading asset management firm.

The Sansar Capital report points out that rising credit penetration is also expected to further fuel banking sector growth. The report cites a World Bank study which shows that Iraqi domestic credit to GDP stood at a mere 9 per cent of GDP at the end of 2011 as compared to a 55 per cent of GDP average for the Mena region.

Domestic credit to GDP grew at a clip of 89 percent CAGR between 2009-2011. Moreover, according to Central Bank of Iraq data, cash credit, such as loans and overdraft facilities, have grown at an impressive CAGR of 50 per cent from 2006-2011.

The detailed report analyses the Iraqi private banking sector through the perspective of five of the country’s largest private banks by deposit. The report reveals that buoyed by strong economic growth and rising credit penetration, these five banks saw their aggregate net income grow by 207 per cent between 2010-2012.

Dilution driven by increases in equity capital resulted in earnings-per-share growth to be lower but still impressive with aggregate EPS growth of 111 per cent from 2010-2012.

The report explores an odd idiosyncrasy in the Iraqi markets where banks with highest Return-on-Equity and growth profiles trade at the lowest valuation multiples. Sansar believes this is an example of market inefficiency which provides opportunity for those paying attention.

The report also closely examines the reported financial statements of the Iraqi banks and demonstrates that adjusted underlying profitability and Return-on-Equity (ROE) for the banks significantly exceeds reported numbers with some banks approaching 60% underlying ROEs.

According to the report, the growth in Iraq’s banking sector earnings and GDP – which IEA forecasts will grow 151 per cent between 2011 and 2020 driven by the country’s increasing oil revenues, go hand-in-hand with the improving security situation in the country. As violence declined by over 80 per cent between 2006-2012, Iraqis in many parts of the country enjoyed relative calm and stability.

However, despite the impressive growth, Iraqi private banks will have to overcome some important challenges if they are to continue their growth at the excellent pace witnessed over the last five years.

Accessibility is among the biggest challenges facing the country’s banking industry. Access to bank branches or ATM machines remains highly limited to the general Iraqi population. There are approximately 900 bank branches covering a population of 33 million Iraqis equating to just one branch serving 36,000 individuals.

Other challenges include an uneven playing field enjoyed by the state-owned banks and a general mistrust of the banking system. This problem is further exasperated by the lack of any deposit insurance institutions that would guarantee customers their deposits back in the event of a bank failure.

The report also raises some concerns regarding corporate governance and transparency at some banks. In the example of North Bank, the report highlights how audit and financial concerns raised by the accountants in the Arabic reports were missing from the English translated reports provided by the bank.

“Iraq’s banking sector, though certainly on the growth path, is not without its share of challenges,” said Sanjay Motwani, president of Sansar Capital.

“However, what is important to note is that all the challenges and hurdles can be overcome, especially with the combined efforts of the government and private sector.

“In particular, we believe that the private sector can help improve accessibility to branch networks and services while the government can help level the playing field between the state-owned and private sector banks. Of course, gaining the trust of the population would require efforts from both sides.”

The report pointed out that Iraqi banks generate large sums of their revenue and profits from trade-financing related activities. For the year 2011, commissions driven by trade-financing related activities (wire transfers, letters of credit, FX spreads) accounted for a range of 28 per cent to 83 per cent of net revenues for the four largest ‘traditional’ banks.

Traditional lending activities such as net interest income on loans became the second largest contributor of revenue with the four largest banks by deposits generating 13 per cent to 49 per cent of net revenues from these activities.

The Sansar Capital report concludes that while the mix of an improving macro environment and security situation offer attractive investment ingredients in Iraq, many challenges remain for those interested in participating through public markets. In such an environment, investors are cautioned to carry out extensive due-diligence including having on the ground presence in the country. – TradeArabia News Service